When President Obama and Congress passed the Jumpstart our Business Startups (JOBS) Act in 2012, it set the wheels in motion for entrepreneurs and small businesses to receive and publicly raise investment funding. It also opened the doors for investors, accredited or not, to invest in certain private offerings. The two new sections under the new ruling – JOBS Act Title II and Title III – changed the rules prohibiting general solicitation and the way companies could raise capital, making crowdfunding possible for private equity.
But, how does JOBS Act Title II specifically impact private equity?
For starters, each private equity transaction must meet an exemption to register. Private equity transactions not in compliance with an exemption are subject to rescission (a re-payment of the money) and potential personal liability for those on the receiving end of the investment.
The majority of those relying on an exemption historically turn to Rule 506(b) of Regulation D. This exemption allows issuers the ability to avoid state filings, offers an unlimited raise amount, and permits up to 35 unaccredited investors.
The JOBS Act Title II’s Rule 506(b), or post-JOBS Act, also bans the issuer from engaging in “general solicitation,” which is where companies communicate with potential investors through press, internet, or otherwise, without having a prior substantive relationship. For example, issuers cannot post on a website, Facebook, or Twitter to announce that a business is looking for funding. Likewise, comments to the press can destroy an issuer’s ability to rely on 506(d).
That’s why more and more entrepreneurs and small businesses are taking advantage of the provisions of 506(c) as an alternative way of receiving funding. Under new Rule 506(c), general solicitation and advertising of a private equity offering is permitted.
The following highlights some of the key differences between Rules 506(b) and (c):
Pre-JOBS Act: If angel investors are not buying through online private equity sites, then they are typically part of a local group of accredited investors called an “angel group.” Here, the group reviews business plans and hears pitches from entrepreneurs on regularly scheduled dates. A common concern from angel networks is the lack of deal flow.
Post-JOBS Act: Investors or brokers can now organize and advertise “open angel networks,” where they can invite all accredited investors through social media, television, radio, newspaper, etc. to hear from local entrepreneurs about their businesses. The supply of money is now being invited by the issuer. And, the sooner the businesses trust and accept this process, the sooner capital begins to flow.
Pre-JOBS Act: The ban on general solicitation nixed many private equity offerings before they even started. To simplify, brokers aren’t going to raise money for a $100,000 offering, and business owners aren’t willing to figure out the entire system and then work the system for that same amount. So, they went to the bank, which said no, and the businesses didn’t do it (or they went out of business). Under these circumstances, private equity was never seen as a viable option for this type of capital raise.
Post-JOBS Act: Over the next decade, businesses will increasingly view the sale of debt or equity to the private market as an alternative to bank debt financing. With the ability to advertise these raises through whatever means necessary, the broker’s job becomes easier, and the barriers to entry for brokers are lower. There could very well be more brokers who recognize this shift and offer their services in a micro-raise capacity.
Pre-JOBS Act: There has been a substantial growth in the online private equity platforms over the past few years. The portals make the market more efficient. But, how will they embrace 506(c)? The general sentiment is, why mess up a good thing, especially when the rules are so unclear?
Post-JOBS Act: The popularity of these online portals will significantly increase the future legalization of securities crowdfunding, bring more online presence, etc. And, as individual investors start to trust the private equity market, and perhaps see a couple of “wins,” their trust in the asset class will increase. Over time, they will change from investors who must see, touch, and feel an issuer into the type who might invest through a platform, without ever meeting the issuer.
Post-JOBS Act: Imagine a finder’s fee for introducing your fraternity brother from college to an issuer through Facebook. Or, imagine advertising the sale of stock on your Facebook page and offering, in addition to the sale of the stock, a free BBQ sandwich each week for a year for each share you buy. Imagine tweeting a link to your followers, and for each follower who turns into an investor, you receive some sort of payment. Imagine the free market research gleaned from an unsuccessful campaign. No one can begin to guess exactly how the private equity/social media interaction will play out.
Post-JOBS Act: Allowing issuers to seek investors will significantly expand the money supply in the market, which will then lead to more raises. More raises entice entrepreneurs to raise capital, which results in additional private equity offerings. All of this leads to more jobs.
Post-JOBS Act: So you’re not into open angel networks. No worries. Keep the group together and hire an entry-level employee to search out private equity offerings. You will find hundreds of deals to parse through each week.
[Editor’s Note: To learn more about the JOBS Act Title II and related topics, you may want to attend the following webinar: The JOBS Act — A Retrospective & A Look Ahead 2018. Read about Private Placements. This is an updated version of an article first published December 2, 2013.]
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Sam Houghton, of HoughtonPA, is a business attorney and entrepreneurial consultant based in Lakeland, Florida. Mr. Houghton’s educational and corporate background is in finance and supply-chain management consulting, having worked directly with Fortune 500 companies to automate and create financial and organizational efficiencies within their businesses. More recent legal experience includes the negotiation and completion…
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